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How to Analyze Stock Market Trends
Have you heard of stock market trends? Oftentimes, you might have heard people say the market is trending, or the market is bullish or bearish. What does this mean? Well, the stock market has a tendency to move in trends. These trends can be bullish or bearish, and can also be sideways. The goal of an investor or trader is to find out where the trend is headed and capitalize on potential investment/trade opportunities that can be discovered using trend analysis.
Trends in the stock market can be short-term that last for a few days or weeks to long-term trends that can last for several months and even years. We at Financial Education believe that understanding the direction of the stock market is crucial for an investor to succeed. In this article, we shall go over what stock market trends are and how you as an investor can identify and benefit from trend analysis. So, let’s get started!
What are Stock Market Trends?
A trend represents the overall direction of an asset’s price and gives investors an idea of where the price might head in the future. Trends can be short-term and long-term and can be identified using several methods and techniques. In technical analysis, trends are generally identified by using trendlines, chart patterns, or moving averages, which eventually help the investor figure out where the market is headed. Stock market trends help investors decide when to buy or sell any kind of stock and also adjust their portfolio according to the current market trend in order to minimize the effect of volatility.
Market trends can be of great help to investors in determining which stocks to buy or sell and when the investment should be made, making trend analysis an important part of every investor’s research. Stock market trends that have a direct relationship with stock prices can be influenced by a couple of factors such as interest rates, inflation, national and international challenges; war, political issues, cybercrime, changes in operational cost in the case of company shares, changes in industrial operations, and actions or inactions of influential people.
A trend provides the general direction of the market or a stock, and it can be either an uptrend, a downtrend, and a sideways trend. All of these trends can be identified using several techniques and methods, which gives an investor a good idea of what might happen next in the market. Uptrends are marked by rising data points, such as higher swing highs and higher swing lows. Downtrends are marked by falling data points, such as lower swing lows and lower swing highs, and a sideways market can be identified using support and resistance on a chart.
Stock market trends have the similitude of human behavioral pattern, in the sense that it reacts to certain kinds of situations which allow investors to be able to make predictions on the movement of the market. But then, these predictions can’t always be accurate, and shouldn’t be trusted blindly. However, in short, market trends are of three types, which are long-term trends, intermediate-term trends, and short-term trends.
What is Trend Analysis?
Trend analysis involves the prediction of future market movement via the use of available data extracted from previous market events. Before beginning a market trend analysis, you will need to decide which sector you are interested in and then select the particular market segment or stock you want to analyze. A visual market trend pattern can easily be seen on the asset’s chart when it is zoomed out.
The movement of stock prices form patterns that can help determine the trend of the stock and provide an overview of its direction. The trend can either be upwards, downwards, or sideways based on the price movement. The upward movement is termed as an uptrend, and downward movements are termed downtrends while the sideways movement is termed sideways trend.
So basically, trend analysis is the process of determining where the price of an asset is headed. This can be achieved by using technical analysis and tools such as trendlines, moving averages, and chart patterns, which all help in the process of understanding where the market or asset is headed in general and therefore, help you capitalize on high potential investment opportunities. Let us understand the three basic type of trends:
A consistent upward movement in an asset’s price is known as an uptrend. Uptrends are marked by using rising data points, such as higher swing highs and higher swing lows. This helps identify that the market participants are willing to purchase the asset at higher prices and therefore signifies that the market is in an uptrend. In an uptrend, investors usually speculate that the stock price has more chances of rising than falling.
As such, investors tend to purchase stocks in an uptrend, causing the price to rise higher. Even when the price tends to drop, investors consider it as an opportunity to buy the stock, with an expectation that it will rise again to yield profit. These drops in price are also known as pullbacks and are often a great point of entry into any stock during an uptrend.
Although, oftentimes, the price of a stock drops more often than it rises during an uptrend, as profit booking comes into play. However, the stock’s price usually ends up positive and results in a consistent and powerful uptrend, as more and more investors are drawn to the increasing returns that the stock offers. As seen in the weekly chart of the S&P 500 Index below, the market index has been in a consistent uptrend since the 2020 Covid market crash. While there have been some pullbacks, the overall market sentiment is bullish and the market is in a powerful uptrend.
In a downtrend, you will observe a consistent drop in the asset’s price. The peaks and the troughs are successively low. Downtrends are marked by falling data points, such as lower swing lows and lower swing highs. This trend indicates that investors no longer have faith in the stock and so they sell off their existing investments whenever they see the price rise even a little.
Downtrends are a no-go area for short-term investors while long-term investors may have to wait for the stock price to drop before buying the stock. However, a market in a downtrend can offer several investment opportunities that might yield huge returns in the future, provided you hold on to the position for a long duration with proper due diligence and research.
In the daily chart of Forward Industries below, you can see that the stock has been in a consistent downtrend since February. The price has been constantly declining and there is a negative market sentiment. While some small upward price movements can be seen, these are the places where investors usually exit all their positions as they become fearful of further losses, and therefore, the downtrend continues
When a market or stock is in a sideways trend, the price usually keeps hovering between certain levels. The market is neither bullish nor bearish, and uncertainty and confusion prevail in the market when the trend is sideways. A sideways trend can be identified using support and resistance and the price usually trades between those two levels.
The outcome of a sideways trend can be both bullish and bearish. The price can either breakout or breakdown. This all depends on how market participants view the stock and what the market sentiment is. This trend keeps investors in an indecisive state, not knowing whether to buy or sell since there is no significant movement in price.
In the weekly chart of Amazon below, you can see that the price has been in a sideways trend and the stock is neither bullish nor bearish. The two green lines plotted on the chart are support and resistance and the stock price can be seen trading in between these two levels. This is a perfect example of a sideways trend.
What is a Trendline?
In order to conduct proper market analysis and determine the trend, you will have to make use of a trendline. A trendline is a line that connects the stock price’s peak or troughs. The trendline connecting the peaks helps you analyze the level of growth the stock has experienced over time, while the line linking the troughs helps investors know how well to manage their risk if they decided to invest in that stock.
Trendlines are a great way of identifying market trends as price patterns can be easily identified using trendlines. Additionally, the combination of the peak and trough trendline is called a channel which makes trend analysis easy. Although the trendline shows the overall direction of the market, sometimes it needs to be redrawn to reflect the most current market price reaction. For instance, if the price goes slightly above the existing trendline and keeps up with an uptrend, then it would be considerate to adjust the trendline to fit the new price reactions.
As seen below in the daily chart of the S&P 500 Index, the price has been respecting the trendline and is in a consistent uptrend.
How to Identify Trends in the Stock Market?
Although stock market patterns can be visually seen from the upward or downward movement of the stock price, identifying the exact trend requires the use of several tools and methods that can be taken from technical analysis. Below are some of the ways you can identify stock market trends –
Multiple Time Frame AnalysisWhen viewing the chart of any stock, there are several timeframes one can use. Charts have several timeframes that consist of yearly, monthly, weekly, daily, hourly, and minute-wise charts. Analysis can be done using any of these time categories. Long-term investors usually make use of the weekly, monthly, and yearly time frame, while short-term investors mostly make use of the daily, weekly, and monthly time frame. However, using multiple timeframe analysis can help you get a good overall picture of the market direction as viewing the stock price in multiple timeframes shows you the big picture and allows you to identify critical price points that can help you make better investment decisions.
Price Study & Market DirectionThe direction of the stock’s price movement, be it upwards, downwards, or sideways will help identify the market trend and the possible direction the price is heading. Using price direction and chart patterns, an investor can identify crucial price levels that can eventually help in the identification of high potential investment opportunities.
Trendlines & Trend SlopeA line drawn on a chart is identified as a trendline when the peak or trough touches the line at least three times. If previous charts are well studied, coupled with the current market situation, then trendline contacts can help in predicting the next contact point, and then give direction on the next trade decision to make. Using trendlines is a great way of identifying trends on several timeframes and identifying where to enter and exit a stock.
Additionally, the slope of the trendline helps in identifying by what amount the price is expected to move daily. Some trends are indicated by upward or downward moving steep lines but in the case where the lines are unusually flat, then the validity and accuracy of the trend are questionable.
How To Trade With The Trend
Founder of Financial Education, Jeremy Lefebvre believes that identifying the overall market trend is a good way of analyzing and predicting future market movements, but using technical tools and methods can boost the predictability of your trend analysis. Here are some tools that you can use while doing your analysis –
Moving AveragesMoving average (MA) is one of the most common technical tool used in predicting the direction of a market. In statistics, a moving average is a calculation to analyze data points by creating a series of averages of different subsets of the full data set. Moving averages that are most commonly used are the 20 DMA, 50 DMA, 100 DMA, and the 200 DMA. These moving averages can help identify the market trend and provide you the exact entry and exit points needed to capitalize on high potential investment opportunities. Some points to consider while using moving averages are –
- A fast-moving average has the potential of taking you out of the market earlier than desired when the market trend is trying to change. Also, when the MA is small, the prediction of the trend might be wrong, as there are chances of it reacting too fast to insignificant market movements.
- The moving average length has a high impact on when a signal is received during market adjustments.
- Using a slow MA tends to give late signals and has the possibility of keeping you on a trade longer than expected.
Line GraphCandlestick and bar charts help in trend analysis, as they give a reasonable amount of detail and information about the market. Yet, taking away the noise in the chart through the use of the line graph will give a clearer view of market price reactions and the overall market trend, making prediction much easier. Line charts remove the volatility and noise of the market, giving you a clearer and holistic view of the market.
Channels and TrendlinesTrendlines and channels are also wonderful tools for market trend analysis. They offer a better understanding of the market range. Trendlines are more efficient when one notices that a trend formation is occurring and the price is nearing the point of contact.
A trendline is formed when the peak or trough of the market price touches a particular line at least three times. Using a trendline is one of the quickest means to know when a market trend has adjusted and when a breakout is taking place. A sudden and sharp breakout from an existing trendline can indicate a transition into a new market trend.
Highs and LowsThe highs and lows of a stock price help in identifying market patterns and plotting trendlines. The conventional technical analysis states that an uptrend is characterized by higher highs and higher lows. In the case of the higher highs, the market is saturated by buyers who by implication push up the market price. Even its lower lows are high, as buyers keep buying the stock, though the price is dipping. The buyers somehow believe that the uptrend will continue.
Conversely, the lower lows occur in a downtrend. Here, sellers sell off their existing stocks which causes the price to drop. With little or no hope for the stock market price to increase, buyers tend to avoid the market making even the higher highs (peaks) low.
Advantages of Trend Analysis
Market trend analysis is beneficial in several ways, just to highlight a few;
- Market trend analysis helps in predicting future market direction, which helps investors decide when to invest and when not to invest in any particular stock.
- Trend analysis helps traders and investors know when the market trend has changed, signaling them to make their analytical adjustments and rebalance their investments.
- Trend analysis helps provide reasonably accurate details of the overall market direction, both of the past for proper forecasting, and the present for future predictions.
Analyzing stock market trends is not as complex as it sounds. Identifying market trends and applying that knowledge while making investments is just a matter of having the right tools backed up with a proper understanding of how the market functions. Doing so will give you an edge when embarking on the analytical process of identifying stock market trends and making your investments.
However, before making any investment decision, always check the current market conditions and other factors that might affect the value of an asset class, as investments in the financial market are subject to market risk. If you liked this article, make sure to visit Jeremy Lefebvre’s YouTube channel “Financial Education” for more such informative content! Happy investing!